Franking credits are an interesting and somewhat unique function of the Australian taxation system. Franking credits can be complex, but understanding them is important for business owners who want to understand their dividend distribution strategy. Investors also need to understand how to calculate franking credits to maximise their returns and minimise their tax bill. We’ll cover all of this and some of the controversy surrounding franking credits in this article.
So What Are Franking Credits?
Simply put, franking credits are a tax rebate that exists in the Australian taxation system to prevent the double taxation of company profits.Â
Franking credits are nothing new. They are part of the dividend imputation system, which has existed in Australia since 1987. Before this, companies would earn a profit, then they would pay company tax on that profit. Then when investors were paid dividends by the company, they’d be required to pay income tax on those same dividends. This meant that the same portion of the profit was taxed twice. The introduction of the dividend imputation system stopped this practice.Â
With the introduction of the dividend imputation system, investors could offset their tax bill by whatever amount has already been taxed by the company on its profits. In some cases, investors in a lower tax bracket—or retirees living on superannuation—can even get a tax refund if they’ve acquired more value in franking credits than they owe in tax.
Here is a really important thing to know about how franking credits affect investing in Australia:
Franking credits offer Australian companies—that earn their profits inside Australia—a competitive advantage in the stock market. This is because the franked dividends of those companies will offer higher returns than non-franked dividends, such as on profits earned overseas. This increases demand for the shares of those Australian companies, making the shares more valuable, and increasing the financial position of those Aussie companies.Â
It encourages companies to make profits in Australia, and likewise, the better dividend earnings encourage investors to put their money in companies that are making profit inside of Australia’s borders.
How do Franking Credits work?
Let’s look at exactly how franking credits work. Franking credits come into play at one step in the taxation process, so we’ll break down the wider process and show you where they fit in.
The Basic Process
- Company Pays Tax: An Australian company makes a profit and pays corporate income tax (either 25% or 30% at the time of writing).
- Dividend Distribution: The company decides to distribute a portion of its after-tax profits to shareholders as dividends.
- Franking Credits Attached: The company can attach franking credits to the dividends, representing the amount of tax already paid on those distributed profits.
- Shareholders Receive Benefit: Shareholders receive both the dividend and the accompanying franking credits.
- Offsetting Tax Liability: When shareholders file their income tax returns, they can use the franking credits to offset their personal income tax. In some cases, if the credits exceed their tax liability, they may even receive a refund.
We’ve been discussing fully franked dividends. But there are also partially franked dividends, and unfranked dividends.Â
A partially franked dividend is paid when a company has already offset their tax through some other subsidy and isn’t required to pay the full company tax rate on its profits.Â
For example, if the ABC received a 50% subsidy on its tax bill then ABC shares would be paid out with a partially franked dividend. The investor could claim a partial franking credit for the 50% tax paid on the profit. But they’d still have to pay for the other 50% that wasn’t paid for by the ABC.Â
Unfranked dividends are dividends with no franking credits attached. This would happen if a company made all of its profits overseas, therefore paying tax overseas as well.Â
Below is a table explaining how much tax someone with a 37% marginal tax rate would pay if they received each of the dividends we’ve mentioned above.
| Scenario | Company Profit (Before Tax) | Company Tax Paid | Dividend Amount | Franking Credit | Investor’s Taxable Income | Investor’s Tax Liability (37%) | Tax Offset | Tax Payable by Investor |
| Fully Franked Dividend | $100 | $30 | $70 | $30 | $100 | $37 | $30 | $7 |
| Partially Franked Dividend | $100 | $15 | $70 | $15 | $85 | $31.45 | $15 | $16.45 |
| Unfranked Dividend | $100 | $0* | $70 | $0 | $70 | $25.90 | $0 | $25.90 |
Still not clear? We can’t say we didn’t try! Check out this 2-minute video on how franking credits work.Â
How To Calculate Franking Credits For My Business
Franking credits represent the tax paid on profits and are attached to dividends, allowing shareholders to offset their income tax. For instance, if your business pays $30 tax on $100 profit, it can distribute a $70 dividend with a $30 franking credit, benefiting shareholders by reducing their tax liability.
Why are Franking Credits Controversial?
Franking credits are a contentious part of the Australian tax system. The main reason for this is that franking credits are seen as mainly benefiting wealthy individuals, particularly high-net-worth retirees. These Australians aren’t taxed on their superannuation, so every franking credit for them isn’t just a tax break but a full refund—allowing them to receive 30¢ extra for every dollar they receive in dividends.Â
As a result, this has sparked a lot of debate about where the money lost to franking credits could otherwise be spent. It’s also worth noting that, while some other nations have systems that are similar to our franking credits, Australia is the only country that offers an outright refund for unused franking credits.
Frequently Asked Questions
Will franking credits be abolished?
Currently, there are no plans to abolish franking credits entirely, but reforms to limit their impact have been discussed.
How to claim franking credits?
Claim franking credits by including them on your tax return under the dividends section, where the credits offset your income tax liability.
Are franking credits counted as income?
Yes, franking credits are counted as part of your taxable income, as they are considered additional income from dividends.
Do franking credits expire?
No, franking credits themselves do not expire. However, they must be claimed in the same tax year the dividends are received.
Do super funds get franking credits?
Yes, superannuation funds can receive and benefit from franking credits, which can offset the tax liability on the fund’s earnings.
Do you pay tax on franking credits?
You do not pay additional tax on franking credits. Instead, they are used to reduce the tax payable on your dividend income.
